Tuesday, August 30, 2016

Two months ago I noted in a post that chemical activity was pointing to a stronger economy. That continues to be the case.

The Chemical Activity Barometer, published monthly by the American Chemistry Council since 1919, is up a solid 3.9% in the past year. This strongly suggests that industrial production—which has been quite weak for the past year or so (due in large part to the big slowdown in oil drilling and exploration)—will pick up in coming months. This should go hand in hand with stronger GDP numbers over the course of the year.

The chart above shows the Chemical Barometer Activity index for the past 8 years. This year's uptick is significant, suggesting at the very least that the underlying trend of economic growth (which has been a little over 2% per year since mid-2009) remains intact.

The chart above shows the Chemical Activity index going back to 1960.

As the above chart shows, the index does a good job of leading the growth in industrial production, and by inference, the overall economy. It continues to suggest that industrial production should enjoy a healthy rebound. For more detailed information, see Calculated Risk.

And as the chart above shows, it indeed looks like Industrial Production is beginning to turn up after almost 18 months of decline.

Two months ago I noted that truck tonnage (above chart) had also picked up. However, it has since dropped back down to where it started the year. Although it's not weak enough to suggest a budding recession, neither is it strong enough to suggest any fundamental improvement in the economy's growth trend. So there's not enough here to get excited about a fundamentally stronger economy. More likely, we will just see a continuation of a growth trend somewhat in excess of 2% per year—a disappointing, sub-par economy, but at least an economy that continues to grow.

21 comments:

Applying the CAB back to 1919, it has been shown to provide a lead of two to 14 months, with an average lead of eight months at cycle peaks as determined by the National Bureau of Economic Research. The median lead was also eight months. At business cycle troughs, the CAB leads by one to seven months, with an average lead of four months. The median lead was three months. The CAB is rebased to the average lead (in months) of an average 100 in the base year (the year 2012 was used) of a reference time series. The latter is the Federal Reserve's Industrial Production Index.

Benjamin: I have been making this argument since earlier this year (i.e., there are effectively no excess reserves due to new regulatory requirements). Whether there is a shortage of reserves is another question. I'm not sure there is, but I'm not worried that the Fed's balance sheet is too big.

I don't get it. The political and economic philosophy to which I ascribe preaches low taxes and limited regulations. The state of California (where Scott and Benjamin both live, I think) rejects both. It leads the US in new regulations, has high corporate and personal income taxes, and everything there is costly: housing, energy, etc.

With all these obstacles to corporate profitability, 4 of the world's 10 largest corporations are headquartered in California. The state's economic output in 2015 was $2.46 trillion compared to France's $2.42 trillion. But California has 40% fewer people!

Then there's California's GDP growth in 2015 of +4.1% vs. +2.4% for the US and +1.1% for France.

What is it about California that enables it to succeed against economic headwinds? Should the whole country simply adopt California's ways and enjoy above average prosperity?

Scott: I get confused on excess reserves. Some say the banks hardly need larger reserves at all, we are talking a few percent, not the trillions of dollars they have. Supposedly, Dodd-Frank and Basel just boosted reserves requirements, not many-fold jumps.

Mmanageddaccounts: California grows as it has the best weather by far in the U.S. Then, it has terrific universities and restaurants. Fantastic commercial culture and also high culture too, if that is what you like. The smog is 95% reduced from when I grew up.

Sadly, CA has gotten crowded as hell, overrun infrastructure, and the artificial scarcity in housing (due to ubiquitous zoning) is terrible.

I moved away for family reasons. L.A. is a lousy place to live, until you try any other major city in the U.S., and then L.A. is a great place to live.

CA does well DESPITE its costly tax structure and regulation not because of it. It is the tech center of the world and yes, it benefits from a nice climate. Don't be delusional and believe you could take their political structure and be successful anywhere else. Look at NY as an example of the pernicious effects of egregious reg/tax on an economy.

In Dec. 2015 the Fed raised interest on excess reserves and the funds rate by 0.25% to 0.50%. That was the last rate hike.

Since then, 10-yeat Treasuries have fallen in yield from about 2.20% to 1.53% (latest).

I suspect Milton Friedman is right about this. A central bank cannot tighten its way to higher interest rates.

So, what happens when the Fed again "raises" rates?

My guess is long-term rates will fall again, leading to a sustained chorus about how low rates are, and the Fed is "hyper-accommodative" etc. And calls for structural changes (though exactly which cows are to be gored is left unsaid, (unless it is gutting the minimum wage and importing lots of cheap labor).

Believe me, I am a free-enterprise guy. You don't want to know how far I would go on free enterprise, but suffice it say there would be no property zoning, universal decriminalized push-cart and truck-vending, no USDA, no HUD, no Commerce Department, no Labor Department, a privatized Coast Guard, a cheap American Foreign Legion and on and on. No TSA. And gut the minimum wage.

The GOP would run unto the arms of Donks if I were in charge!

That said, in the real, cluttered, mixed-economy world where we live, what will be the result of another rate hike by the Fed? My guess is we see 10-year Treasuries go lower, By another 70 basis bias points, like after the last rate hike?

I am with you on departments and agencies to eliminate, although I'm not sure about the USDA. We need to know our food is safe. I cannot imagine how quickly the unemployment rate would drop if we did away with the minimum wage. So many who cannot find a job because their labor skills are not worth the going minimum wage could negotiate for what they are really worth.

We ought to be able to eliminate the Depts. of Education and Energy. I just don't expect any downsizing of government. It won't happen under the Dems, nor will it happen with the GOP.

If the Fed raises the target for the funds rate, it is likely to move longer-term rates lower and could result in a negative yield curve----not good! We've not only got scared money going into Treasury Notes, but there's foreign money flowing into Treasury Bonds.

If we need all the infrastructure spending that Democrats and liberals are constantly calling for, why don't we borrow a Trillion Dollars for 30 years at 1.6% or 2.3% and get all our infrastructure needs up-to-date and in 21st century condition, plus it would eliminate one constant harp of liberals. I know what they would say, "We need more." Yep. We always do.

I live in Florida and for the most part our roads are excellent. I-4 needs two more lanes in each direction, but most of the other roads are in pretty good condition. A number of our ports have been improved to accommodate bigger ships coming through the wider Panama Canal. Our major international airports are under constant construction. I don't know about rail, water and sewer lines, the power grid, etc. but I think our bridges are in excellent condition. Where's the need for massive infrastructure spending?

Investing, he says, always is “an act of trust—in the ability of civilization and the U.S. to continue to flourish; in the ability of corporations to continue, through efficiency and entrepreneurship and innovation, to provide substantial returns.” But nothing, not even American greatness, is guaranteed, he adds.

My read of the freight index and related indices is different. The TSI index is actually up year over year through June, but it has been in a flat trend for the past 18 months. The major source of weakness comes from a decline in carloads, but that is mainly due to a decline in shipments of petroleum and coal, and those declines have a lot to do with increased natural gas production (natural gas supplanting petroleum and coal for energy production, which is a quite healthy development). On balance, I think transportation indices are consistent with an economy that is growing slowly and has slowed down a bit over the past year. They do not point to a general downturn in the economy.

Thank you for your input. I felt like it was a headline to get people talking but know that we are in that consistent plow horse kind of mode. As I get older I see the MSM play off of one fear or another to get people watching. Thanks again for your thoughts. Tom.

I would further point out that the Chemical Activity Barometer includes August data, whereas the TSI index only includes data through June. Moreover, the CAB shows a pronounced strengthening year to date.